Pitfalls of practice valuation - By Chris Vowles MRICS

The dental sector offers a unique challenge for RICS Registered Valuers when undertaking the valuation of a practice. In a market experiencing constant and rapid change, many factors can affect valuation including ownership, income mix, contract type, UDA value and location.

In order to avoid confusion, it is important to have an understanding of the terminology used by agents and RICS accredited valuers when considering a Market Value. This can include distinguishing between valuations for marketing purposes and professionally qualified RICS Registered Valuations. It is also important to understand the fundamental differences between EBITDA valuations against turnover valuations. 

A valuation for marketing purposes as opposed to an RICS Registered Valuation is a market assessment that takes competitive bidding, desirability and special purchase value of a practice into account. The value is based on what an agent considers they could achieve rather than purely on market evidence from previous transactions. In contrast to this, an RICS Registered Valuation is “the estimated amount for which an asset or liability should exchange on the valuation date between a willing buyer and a willing seller in an arm’s length transaction after proper marketing and where the parties had each acted knowledgeably, prudently and without compulsion”. It is also the Market Value that a lending institution would be willing to lend, or securitize monies against and is considered an Open Market appraisal.

An EBITDA (earnings before interest, tax, depreciation and amortisation) valuation is based on the loan serviceability of the asset. The EBITDA relates to the ability to repay the debt and costs incurred in operating the business, while a turnover valuation is based simply on a percentage of the turnover of a practice, and not its profitability.

When it comes to borrowing, although the dental industry is often referred to as a ‘green-light’ sector in terms of securing finance for practice purchases, this is founded on commercial valuations rather than proposed sale prices. It is useful to note that banks will only lend against the RICS value incorporating both EBITDA and turnover approaches and not just the predicted sales price.                                                                             

Serviceability of debt funding

When considering purchasing a practice, practitioners should be aware of the dangers in neglecting the serviceability of the debt incurred. This can result in there being insufficient monies to pay the debt down and meet practice bills, once a personal salary has been deducted. In a situation where an owner-operated practice has a profit of say £100,000 per annum, the practitioner may desire a salary of £80,000, leaving £20,000 to meet any finance charges. However, as a practice that makes £100,000 profit is likely to be worth £400,000, if the practitioner has borrowed the full value i.e. £400,000, the serviceability of such a debt on this business is going to be approximately£45,000 to £50,000 per year over ten years, resulting in the practitioner earning a figure closer to £30,000 a year. The situation is therefore not financially viable, the practitioner’s judgement clouded by the turnover value of a practice and the desire to operate their own practice. Ignoring the serviceability of debt funding can sadly result in being unable to afford the practice.

Competitive bidding

There is a significant gulf between market value – what a bank-backed valuation would amount to – and special purchase value – what an individual would be willing to pay. Indeed, due to the high desirability of owning a dental practice compared to the relatively low supply available, private individuals are often prepared to pay more than corporate bidders who are interested in the profitability and performance of a practice. This creates an environment of competitive bidding, which tends to inflate values and prices significantly.

This unique situation in the dental market causes difficulties for RICS Registered Valuers seeking to draw on previous ‘deals’ as precedents, posing further complications in the valuation process. The dental sector also demonstrates a reluctance to reveal details behind previous transactions, due to the highly competitive arena. This is in contrast to other areas, such as the residential market, where valuers might share information, providing a clear picture of the market landscape.

Freehold

Finally, freehold properties can present some of the biggest points of contention within the sector. For instance, a practitioner may purchase a residential building for a certain amount and then decide to spend a further £100,000 converting it into a dental practice. In their opinion the practice should then be worth the original value of the house plus the money spent on converting it. However, when a rent investment calculator is applied to it, it may actually only be worth a figure much closer to the initial cost of the residential building. Furthermore, because of its residential setting it could then be difficult to re-market or sell for D1 planning purposes. 

More complications will occur if looking to sell on as a residential building, as it may be worth the initial price as set by a local estate agent, but only once converted back into a residential building. This would then make the building worth less than the initial price paid for it. As this example demonstrates, the importance of understanding freehold property valuations cannot be underestimated. 

When trying to understand what a practice is actually worth, achieving a true market value assessment from an RICS Registered Valuer will always be extremely beneficial.

Christie+Co has a thorough understanding of the dental market and 15 regional offices providing a consistent approach across the country. This also allows local valuers who understand regional variances to assess the value of the asset. When looking for a practice valuation that is appropriate to your situation and that will achieve the best price, contact the experienced brokers at Christie+Co.  

To discuss how Christie+Co might help you achieve your future plans please contact Chris Vowles on 0121 456 1222

Christopher Vowles MRICS is an RICS Registered Valuer specialising in dental valuations and a Director at Christie+Co.